Autos' Subprime Shock

Housing and credit woes are the last things ailing U.S. automakers wanted to hear about right now. Can Detroit survive slower demand for cars?

By Jim Ostroff, Associate Editor, The Kiplinger Letter

September 4, 2007

The mortgage mess spells trouble for automakers. U.S. vehicle sales were already losing steam before mortgage and housing jitters reached fever pitch in August. Now the auto sales outlook is becoming downright dismal, as more-cautious consumers delay nonessential purchases.

U.S. automakers, like home builders, have depended on easy financing to attract customers. But the mortgage-led credit squeeze will make it difficult for manufacturers to offer loans with features such as payback periods stretching six or seven years and low or zero interest rates. Why? Auto companies are seeing their own financing costs soar. For example, they have to offer higher rates on the corporate bonds they issue in order to attract investors. Less cheap money for the auto manufacturers means less cheap credit available for potential car buyers.

Strapped households won't hesitate to postpone plans to buy a new car, typically one of the first sacrifices consumers make in times of financial uncertainty. After all, that old car can be used for a good while longer, even if it may not be as flashy, reliable or fuel efficient as a newer model. This sets the stage for total U.S. auto sales to slip to a paltry 15.7 million or so next year from 15.9 million this year. These figures will be a far cry from the roughly 17 million a year that ailing U.S. automakers had expected during the latter years of this decade.

Bottom line: 2008 will be grueling for Detroit's trio of carmakers -- General Motors, Ford and the recently sold Chrysler -- which were hoping for improved fortunes next year. But as the economic drag from housing wears on, at least through the middle of 2008, it's unlikely that the U.S. automakers will see daylight. Their combined share of the U.S. market is already on track to slip below 50% this year, and it will fall even further next year.

We see one of the Detroit car companies throwing in the towel by 2010, probably leading to a merger with another automaker. The most likely candidate is Ford, already in the weakest financial shape of the three. Its sales were down 14% in August from the same month in 2006. Ford's domestic market share has plummeted in recent years and should come in at 14.5% this year, down from 17.2% in 2005. Next year, Ford will be lucky to capture 14% of the market.

Rebecca Lindland, director of industry research for the Americas at Global Insight, an economic consultancy, says Ford will pay a steep price for its lack of new models that could help pump up sales. "Ford's new Edge [crossover SUV] has done well, but [the company] has little else in the pipeline." That's a concern, says Lindland, because cost cutting can go only so far in improving the company's performance. "It needs good, new products to generate revenues," she adds.

Unless Ford can turn around the slumping sales of its core pickup truck line, the company will simply run out of cash and be forced to find outside help. In effect, the housing slump is a worst-case scenario for Ford because construction firms and their workers are a key market for pickups. Less home building thus means less demand. Erich Merkle, vice president of forecasting with IRN Inc., an automotive consulting firm, says Ford's only option to prop up sales would probably be to boost cash incentives on its featured F-series pickups. But he points out that this would only accelerate Ford's cash burn, making it even tougher for the company to achieve its goal of returning to profitability in 2009.

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